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Is It Time to Buy Argentine ADRs?

As you might have heard, Argentina is facing strong pressure on its currency, which dropped about 12% last week. The country's central bank has been intervening in its currency markets since 2011, when government officials decided to progressively increase restrictions on buying foreign currency, leading to the creation of a black market for cash operations and wire transfers denominated in dollars. This market, although small, has a 60% spread compared to the official market, which is very hard to access. This past Monday, Argentine officials started to ease these restrictions while stabilizing the Argentine peso and raising interest rates. The outcome of this strategy is yet to be seen.

OK, but how are Argentine ADRs performing?Well, as you might have guessed, they are making a correction. YPF SA(NYSE:YPF), the country's petroleum company, dropped 28.7% in January alone -- more than any other Argentine company. Although YPF's fundamentals remain solid, investor panic pushed by the country's short-term outlook could make it drop even more.

Petroleum-wise, Argentina is unfortunately not self-sufficient. In fact, these past few years the country had to face higher energy imports. Last year, Argentina imported more than $11 billion in energy; most of this was subsidized fuel. Although this situation is not particularly negative for YPF, it is for the state, which holds the controlling stake in the company, and this deficit adds strong pressure on its central bank reserves.

YPF must also find a settlement with Repsol, the Spanish oil company that used to own YPF until the Argentine government unilaterally decided to nationalize 51% of the company's stock without paying for it. Negotiations are taking place, and we will probably see an agreement this year. This settlement will definitely unlock access to the investments YPF needs to develop its Vaca Muerta shale oil and gas formation, which holds about 16.2 billion barrels of oil and 308 trillion cubic feet of gas.

DroppingAnother company that took a hit is Transportadora Gas del Sur(NYSE:TGS), which exploits, distributes, and sells natural gas. TGS is important to the country, as it owns 4,744 miles of pipelines. Along with an extra 927 miles that are under the company's management, these pipelines transport about 60% of all of Argentina's gas and sell it to retailers.

The company dropped about 15% this year for similar reasons to YPF. However, TGS' fundamentals have not changed. The company has no competitors in its area, as it is the only one transporting gas from the south of the country. Its only real competitor would be Transportadora Gas del Norte, which performs similar operations in the north of the country. It is important to notice that Argentina is the eighth-largest country in the world, so there is quite some space to cover.

Over the last seven years, Transportadora has been showing consistent profits, and it boasts a sound balance sheet. In addition, the company can serve its debt and has a solid track record as a high-yield dividend-payer for the last five years.

What about banks?Finally, let's take a look at Argentina-based financial-services holding company Grupo Financiero Galicia(NASDAQ:GGAL).

Despite some ups and downs, the bank has dropped about 23% this year. It is important to understand that whenever there's uncertainty, financial institutions are the first ones to make corrections. Argentina is no exception. Further, this sector is being questionedby the government for high speculation and for fueling the latest pressure on the peso. The bank, among others, could potentially be investigated for certain foreign exchange transactions performed on the day when the peso dropped 12%, as well as other rounds in which the central bank had to intervene in the spot and future markets to support the currency. Even the president made comments about these issues.

Although these accusations are hard to prove and might not be grounded, local investors expect that sanctions might be applied to local banks. Grupo Financiero Galicia holds a strong market position in the country, and its profitability and brand reputation could be damaged in the short term.

With its lending activities paralyzed because of the uncertainty, high interest rates, and high inflation, cash flow for the bank is backed by fees charged to clients for transactions and other concepts. These fees are highly regulated, and with inflation estimated to reach at least 30% in 2014, profitability could be damaged.

Final thoughtsUnfortunately, Argentina is not the only country making a correction. Other emerging markets like Turkey and South Africa are showing significant capital flying away to find refuge somewhere else as well. Although this could be temporary, the signs of a recovery have not yet arrived.

Regarding YPF, the local government has set a state priority to make the company profitable. It will do this by allowing price increases that greatly surpass the local inflation rate. All of the necessary subsidized imports of equipment and fuel will be facilitated, and the future settlement with Repsol will give access to cheaper credit and allow partnerships to increase production. If you are willing to take the risk, it is a good stock for long-term positions.

For similar reasons, TGS could be an interesting investment. However, the company might make a correction in the short term. Be prepared.

Grupo Financiero Galicia will probably experience near-term volatility. For now it is a stock to avoid, unless you follow it closely.

Author

I am a curious economist who likes to investigate what is behind asset price movements across the globe. My articles range from industry analysis of various sectors to understanding global macro events that could trigger volatility in the markets.